Is a recession coming to the US? Here’s what to watch for

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The Observer US economy Is a recession coming to the US? Here’s what to watch for

Unemployment is at lows last seen 50 years ago and stock markets, while wobbly, are close to record highs, but a shadow looms

Traders work before the closing bell at the New York Stock Exchange on 14 August as stocks plummeted about 800 points. Photograph: Johannes Eisele/AFP/Getty Images

It’s 10 years since the great recession and by many measures the US economy is still booming. Unemployment is at lows last seen 50 years ago, stock markets, while wobbly, are close to record highs, consumer confidence is high and shoppers keep shopping. And yet there is a shadow over America.

A chorus of economists are warning that the chances of a recession are growing. The Trump administration’s trade war with China is taking its toll abroad and there are now signs it’s coming home. This week #TrumpRecession started trending on Twitter as US stock markets suffered their worst day of the year.

Donald Trump pledged to bring back manufacturing jobs and end “unfair” trade relationships with the US’s biggest trading partners. Though economists have long argued over how much control a president really has over the economy, this one can move the markets with a tweet. And while Trump has enjoyed the fruits of this long-running economic boom his policies are also inextricably tied to the issues now rattling investors.

This week’s market sell off came after a keenly watched economic indicator, the yield curve, started flashing warning lights. Could the longest economic expansion in US history be finally heading for recession?

Here are the areas you need to keep an eye on:

Yield curve

Every recession of the last 60 years has been preceded by an inverted yield curve. The term is off-puttingly wonky but it just means investors see trouble ahead.

US treasury bonds are regarded as safe investments. Usually investors expect higher returns for tying their money up in long-term bonds than they do for short-term bonds. When long-term bonds offer lower interest rates than short-term ones, the yield curve has inverted.

This week yields on the 10-year treasuries fell below two-year yields for the first time since 2007. Looking at yield curves, the New York Fed now puts the probability of a recession by July 2020 at 31.5%– close to one in three.

There’s some argument that the oracular power of inversions ain’t what it used to be thanks to the aggressive monetary policies that have been pursued by central banks around the world.

But Gus Faucher, PNC bank’s chief economist, still sees inverted yields as “a very reliable indicator”. Faucher is betting on a slowdown rather than a recession next year but either way he argues inverted yield curves are bad news.

Verdict: Negative sign

Jobs

“JOBS, JOBS, JOBS! #MAGA” Trump tweeted last month, sharing a graph that showed gains in employment across a broad swath of industries from professional services to mining.

Donald J. Trump (@realDonaldTrump)

JOBS, JOBS, JOBS! #MAGA🇺🇸 pic.twitter.com/HScS4Y9ZJK

July 12, 2017

The US has now added jobs for 106 months in a row, the longest streak on record. The unemployment rate, at 3.7%, is close to its lowest recorded level, 3.6% in 1969. There is no sign of a pickup in claims for unemployment benefits.

The pace of jobs growth is slowing, however. Employers added 165,000 jobs a month, on average, over the first seven months of the year, down from an average of 223,000 a month in 2018. And wages – which have lagged behind employment growth ever since the end of the recession – are still growing slowly, up just 3.2% in July from a year ago.

In a recent note Capital Economics pointed out that every recession in the past 50 years was marked by a significant rise in jobless claims that began slightly before, or at the time, that recession began. “With claims still close to a 50-year low, it would be highly unusual if the economy was already in recession (or anywhere near it) right now,” wrote chief US economist Paul Ashworth.

Verdict: Positive sign

Stock markets

“The periods of boredom have grown shorter and shorter – and the terrors last a bit longer,” said Arthur Cashin, director of floor operations for UBS Financial Services at the New York Stock Exchange.

US stock markets hit another record high last month but the daily swings in share prices are giving investors motion sickness. The Dow lost 800 points (3%) on Wednesday, its worst performance of the year, rattled by the inverted yield curve and fears that the trade war with China would escalate.

But the S&P 500 is up close to 26% since Trump took office (it rose 175.9% under Obama, albeit from a crushing low) and has continued to rise as investors have looked for ways to make money in a low interest rate environment.

As indicators go, stock market falls don’t have a great track record of predicting recessions. Markets dropped before the 2001 recession and at the start of the 2008 recession but, according to an analysis by Ben Carlson, a portfolio manager at Ritholtz Wealth Management, most recessions are not preceded by stock market falls. “We’ll have a recession at some point but odds are the stock market won’t tip us off ahead of time,” writes Carlson.

Verdict: worrying but not predictive sign

Gross Domestic Product

It takes two consecutive quarters of negative economic growth to make a recession. The US, the world’s largest economy, accounts for about a quarter of global gross domestic product (GDP) – the broadest measure of economic health. Last quarter, US GDP slowed to 2.1%, down from 3.1% in the first three months of the year and well below the 2018’s 2.9% growth. Meh, but still positive.

The major headwind for slowing growth in the US is Trump’s signature economic policy: trade wars. Trump has started spats with all of the US’s largest trading partners.

The dispute with China, the world’s second largest economy, worries economists the most. In July industrial output growth dropped to a more than 17-year low in China and that was before a new round of tariffs were announced by Trump. The latest levies have been delayed – to spare Christmas shoppers – but they are still coming. This month Goldman Sachs chief economist Jan Hatzius warned: “Fears that the trade war will trigger a recession are growing.”

Meanwhile in Europe Germany is suffering as the US and China go head to head. Growth slowed to 0.1% in the three months to the end of June. Brexit is taking its toll , not least in the UK where the government has announced the first fall in quarterly GDP in six and a half years.

Exports of goods and services from the US account for about 12% of US GDP, consumer spending, which remains robust, accounts for close to 68%. The US has so far weathered Trump’s trade tirade, but how long will that continue as goods increase in price and the economies of its trading partners weaken? The second quarter US GDP figures will be revised at the end of the month and the third quarter figure will be released in November. They will be the next big measure of whether, or not, the US boom is turning to bust and the Fed is already predicting another slowdown.

Verdict: negative sign

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